The price-to-earnings (P/E) multiple enjoys wide-scale popularity among investors seeking stocks trading at a bargain. In addition to being a widely used tool for screening stocks, P/E is a popular metric to work out the fair market value of a firm. But even this ubiquitously used valuation multiple has a few limitations.

While P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV-to-EBITDA is sometimes viewed as a better alternative. EV-to-EBITDA gives the true picture of a company’s valuation and earnings potential. It has a more comprehensive approach to valuation.

Group 1 Automotive, Inc. GPI, Titan Machinery Inc. TITN, AAR Corp. AIR, Corebridge Financial, Inc. CRBG and CEMEX, S.A.B. de C.V. CX are some stocks with attractive EV-to-EBITDA ratios.

Is EV-to-EBITDA a Better Substitute to P/E?

EV-to-EBITDA is essentially the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). EV is the sum of a company’s market capitalization, its debt and preferred stock minus cash and cash equivalents.

EBITDA, the other component of the multiple, gives a better idea of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.

Just like P/E, the lower the EV-to-EBITDA ratio, the more attractive it is. A low EV-to-EBITDA ratio could signal that a stock is potentially undervalued.

EV-to-EBITDA takes into account the debt on a company’s balance sheet that the P/E ratio does not. Due to this reason, EV-to-EBITDA is generally used to value the potential acquisition targets as it shows the amount of debt the acquirer has to assume. Stocks boasting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates.

Another shortcoming of P/E is that it can’t be used to value a loss-making firm. A company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV-to-EBITDA is difficult to manipulate and can also be used to value companies making losses but are EBITDA-positive.

EV-to-EBITDA is also a useful tool in measuring the value of firms that are highly leveraged and have a high degree of depreciation. Moreover, it can be used to compare companies with different levels of debt.

However, EV-to-EBITDA is not devoid of shortcomings and alone cannot conclusively determine a stock’s inherent potential and future performance. The multiple varies across industries and is usually not appropriate while comparing stocks in different industries, given their diverse capital expenditure requirements.

A strategy solely based on EV-to-EBITDA might not yield the desired results. However, you can club it with the other major ratios in your stock-investing toolbox such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen value stocks.

Screening Criteria

Here are the parameters to screen for value stocks:

EV-to-EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV-to-EBITDA ratio represents a cheaper valuation.

P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.

P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.

P/S less than X-Industry Median: The lower the P/S ratio, the more attractive the stock is, as investors will have to pay a smaller price for the same amount of sales generated by the company.

Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.

Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.

Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.

Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have always managed to beat adversities and outperform the market.

Value Score of less than or equal to B: Our research shows that stocks with a Value Score of A or B, when combined with a Zacks Rank #1 or 2, offer the best upside potential.

Here are our five picks out of the 12 stocks that passed the screen:

Group 1 Automotive is one of the leading automotive retailers in the world. GPI, a Zacks Rank #2 stock, has a Value Score of A.

The Zacks Consensus Estimate for Group 1 Automotive’s current-year earnings has been revised 8.4% upward over the past 60 days. GPI’s earnings beat the Zacks Consensus Estimate in each of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 8%, on average.

Titan Machinery operates a network of full-service agricultural and construction equipment dealer locations in North America and Europe. This Zacks Rank #2 stock has a Value Score of A.

Titan Machinery has an expected year-over-year earnings growth rate of 9.7% for the current fiscal year. TITN’s earnings beat the Zacks Consensus Estimate in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 18.5%, on average.

AAR provides various products and services to the aviation and defense industries worldwide. AIR, a Zacks Rank #2 stock, has a Value Score of A.

AAR has an expected year-over-year earnings growth rate of 21% for the current fiscal. The consensus estimate for AIR’s current fiscal-year earnings has been revised 1.8% upward over the last 60 days.

Corebridge Financial provides retirement solutions and insurance products. This Zacks Rank #2 stock has a Value Score of A.

Corebridge Financial has an expected year-over-year earnings growth rate of 45.6% for the current year. The Zacks Consensus Estimate for CRBG’s current-year earnings has been revised 5.6% upward over the past 60 days.

CEMEX is a global construction materials company. This Zacks Rank #2 stock has a Value Score of A.

CEMEX has an expected year-over-year earnings growth rate of 125% for the current year. The Zacks Consensus Estimate for CX’s current-year earnings has been revised 15.7% upward over the last 60 days.
Cemex S.A.B. de C.V. (CX): Free Stock Analysis Report

AAR Corp. (AIR): Free Stock Analysis Report

Group 1 Automotive, Inc. (GPI): Free Stock Analysis Report

Titan Machinery Inc. (TITN): Free Stock Analysis Report

Corebridge Financial, Inc. (CRBG): Free Stock Analysis Report

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